Carlyle likely to do more money manager deals

Carlyle Group's acquisition of money manager TCW Group Inc. is getting mostly raves, and could be the first of several institutional money manager investments Carlyle makes.

Under the Aug. 9 deal, TCW's management and key employees' ownership will grow to 40% from 17%. Another plus: TCW executives expect all portfolio managers will stick around — albeit with lower overall compensation. There are 36 portfolio managers, including managers in TCW joint ventures.

The deal, financial terms of which were not disclosed, is expected to close in the first quarter of 2013.

For limited partners in the two Carlyle funds taking a 60% stake in TCW — the $1.1 billion Carlyle Global Financial Services Partners LP and the $13.7 billion U.S. buyout fund Carlyle Partners V — Carlyle is tapping in on the growing opportunity of investing in financial services companies.

Officials at CalSTRS, a client of both TCW and Carlyle, are pleased with the buyout.

“We think it's a good thing. We think the most positive aspect is the management ownership increases,” said Ricardo Duran, spokesman for the $150.6 billion California State Teachers' Retirement System, West Sacramento. “This gives them more skin in the game.” CalSTRS has a $500 million commitment to Carlyle Partners V and $270 million with TCW in a domestic small-cap growth equity strategy.

“We see no problem with (CalSTRS') portfolio because of this,” Mr. Duran said. “As an investor, we are seeing a positive impact on the private equity and public equity sides.”

The most important thing for private equity investors in general is that buyout teams — particularly Carlyle — are expert in owning financial services companies, said Dennis McCrary, partner and global head of co-investment in the San Francisco office of U.K. private equity firm Pantheon Ventures Ltd., which co-invests on deals and invests on the secondary market.

A buyout of a financial services firm is not your average private equity deal.

“Private equity firms that possess specific industry expertise and investment experience in the financial services sector will outperform and avoid pitfalls facing more generalist firms,” he said, adding Carlyle is one firm that has that expertise.

With a money manager, private equity firms need to know whether it can increase its assets under management.

“Succeeding in the investment management business ... requires a unique set of skills including marketing, client service and of course strong investment performance. Private equity firms need to understand the subtleties in these different businesses to buy wisely and optimize value,” Mr. McCrary said.

TCW had $131 billion in AUM as of July 31, up 10% from the first of the year, according to TCW. Most of its growth has been from its $43 billion in mutual fund assets, up 26% year to date. Most of TCW's assets are in fixed income, with $76.9 billion in domestic fixed income and $12.7 billion in international assets, which is mostly fixed income, compared with $20.5 billion in equities and $17.2 billion in alternative investments.

Carlyle in 2007 created a team of investment professionals with financial sector expertise and the next year, hired Olivier Sarkozy, managing director and head of Carlyle's global financial services group.

The TCW deal is the 12th made by Carlyle's financial services group and its first majority stake in an institutional money manager. It could be Carlyle's first of several investments in institutional financial service companies, sources said.

A private equity fund deal also puts a different spin on a traditional money management M&A transaction.

Private equity acquisitions have an expiration date. The typical ownership period for private equity funds such as the two Carlyle funds that together will hold a majority stake in TCW is five to seven years. While TCW and Carlyle executives say it's too soon to discuss an exit strategy, insiders believe the most likely exit is an initial public offering, which will ensure TCW stays independent.

That independence should be welcome news for TCW's portfolio managers —including the team from Metropolitan West Asset Management LLC that joined TCW at the end of 2009. Under the deal, portfolio managers overseeing 89% of TCW's assets have accepted new long-term contracts that included cutting their compensation in exchange for obtaining equity in the firm on top of what they already hold, said Peter Viles, spokesman. He declined to say how many portfolio managers accepted the deal.

David Lippman, previously group managing director and head of fixed income at TCW, became president and CEO of TCW Group when the buyout was announced on Aug. 9. Mr. Lippman replaces Marc I. Stern, vice chairman, who will become chairman of the newly formed TCW board of managers when the deal closes. MetWest co-founder Laird R. Landmann will have a board seat.

Among the portfolio managers remaining in their current roles are Tad Rivelle, TCW's chief investment officer of high-grade fixed income; Bryan T. Whalen, managing director in the U.S. fixed-income group, who co-heads mortgage-backed securities; Craig Blum, Diane Jaffee, R. Brendt Stallings and Husam Nazer, equity group managing directors; and Penny Foley and David Robbins, both managing directors, who lead TCW's emerging markets group.

Still, not everyone is uncorking champagne just yet.

“We're sitting tight. We like MetWest, and while you have uncertainty with any ownership change, we think it (Carlyle) is a better ownership than it was before,” said Jeffrey MacLean, CEO of investment consultant Wurts & Associates, Seattle.

Mr. MacLean said the issue is whether investment strategies other than fixed income will remain “core competencies” for TCW. Investors in those strategies should be concerned whether TCW management will be able to retain their best investment executives.

Another cause for concern is that Carlyle Group and TCW might have overlapping strategies. Although TCW has witnessed most of its growth in its fixed-income mutual fund business, both retail and institutional, it has plans to expand its alternative investment business, Mr. Viles acknowledged.

This could create a potential for conflict. For example, both TCW and Carlyle have a distressed debt business.

Carlyle's other private equity investors also have cause for some concern. Carlyle executives have stressed that very little leverage was used in the acquisition. Industry insiders say TCW was not a strong buyout target. Without a lot of leverage, which can boost returns, Carlyle would have had to have gotten a good price for TCW, industry sources say.

Word on the street is that despite Carlyle having to fend off other firms bidding for TCW, the private equity firm got a good price. A Carlyle spokesman wouldn't discuss the price tag.

Still, observers expect to see a lot more private equity firms buying up money management firms.

The deal flow for money management firms is strong because many are struggling, said Carsten Huwendiek, principal at Pantheon.

A number of private equity firms are “getting their arms around” the opportunity left by the disruption in financial services stemming from the recession, Pantheon's Mr. McCrary said.